London 1970 - 1976: A case study into Real Estate Market Cycles

Executive Summary: London 1974 - why did the bubble burst?

The boom arose from multiple causes

The concurrence of several factors – a strong business cycle, a lagging property development cycle further constrained by regulation, an accommodative credit cycle enhanced by banking liberalisation and a misguided monetary policy – triggered a boom in the London commercial real estate market of the early 1970s.

The subsequent bust in 1974 was triggered by the sharp rise in oil prices that lifted the United Kingdom inflation rate and caused the Bank of England to immediately increase the policy Minimum Lending Rate and impose price and wage controls that limited rent increases. But these measures would not have been accompanied by the severe London office market crash had market conditions not been conducive to a property market collapse.

Lax financial discipline led to a financial crisis

Due to over-lending to the property market and excessive gearing, the property market crash and ensuing loan defaults created a significant banking crisis. The Bank of England sponsored a rescue package dubbed "the lifeboat operation", wherein the major clearing banks, along with large insurance and pension companies, participated in providing funding to the troubled secondary banks that were overexposed to the ailing property market.

The London market experience highlights common features of real estate cycles

Some believe that the 1974 real estate bust and associated banking crisis were exceptional, resulting from poor publicpolicy decisions and flaws in banking regulation. However, subsequent boom-bust cycles and crises have revealed several common factors. Recurrent building cycles, when coinciding with expansionary credit cycles, can result in a feedback loop of asset inflation, over-gearing and over-lending to the property sector. The real estate market thus becomes prone to an abrupt end-of-cycle bust if the cost or availability of credit is reversed too swiftly. Indeed, the property market's interconnectivity with the financial sector poses a systemic risk to the overall economy, if capital values should drop suddenly and extensively.